What is an Investment?
Investment vs. Inflation
The most feared word in economy and finance is probably “Inflation”, for many is their worst nightmare and hundreds of governments unsuccessfully tried to stop it during decades. Lately, inflation is tormenting developed countries who thought they had controlled this old-known ghost. But, what does inflation actually mean? Inflation is the fall in purchasing value of money, reflected on a general increase in prices. A great and simple example of inflation is the price of the Big Mac, in 2004 in the USA the burger’s price was $2.90, while this year (2022) burger’s price is $5.81. As you can see the Big Mac’s price has doubled in 16 years, this means there was an accumulated inflation of 100%. This example shows how the purchasing power of the US Dollar has decreased, with $6 back in 2004 you could buy two burgers while you could only buy one nowadays. As you might have realized, saving money for many years doesn’t make a lot of sense since one might be losing purchasing power year by year.
Now that we understand the concept of inflation and how it affects our life, maybe a second question arises, since we as individuals can’t control inflation, what can we do to fight against it? If you want to accumulate money without losing purchasing power against inflation, you can invest your money, put your money to work. Investing means using money to create income, building wealth. Let us remind you that investing is by definition risky, as there is never a 100% chance your expected return will be fulfilled. However, by investing you may maintain your purchasing power across time and you might even beat inflation.
Investment Account vs. Safe Box
To understand the difference between an Investment Account and a Safe Box we must first understand the difference between Investing and Saving.
Let’s start with a quick definition of Saving: not spending. A mathematical view can describe savings as: what you earn minus what you spend. Therefore savings are kept in cash or, in some cases, cash equivalents. Savings are usually accumulated in savings accounts or at safe boxes, these are theoretically the safest way to keep your money. The problem with savings is that, in almost every economy, they will lose value over time, due to inflation. So, although your cash won’t change, with the passing of time your purchasing power will decrease. We can conclude that, Savings are supposed to be the safest way to keep money, but in some sense by doing nothing you are actually losing money, because of, as mentioned before, inflation.
Luckily by Investing you can use your money to try to make more money. As opposed to saving money, investing means putting money to work, and there are several ways to do so, such as buying real estate, starting a company, lending money for interests or buying stocks.
As you might have realized there is inherent risk in investing. Of course there are different levels of risk, e.g. lending money to the US Government (investing in US Treasury bonds) will probably be safer than lending money to a company that has no profit at all. And you might wonder, why would someone take greater risk while investing? Usually, higher returns require higher risk, that is an implicit rule in finance. So in order to seek higher profits while investing the exposure to losing will typically be higher.
Now we can clearly see the difference between an Investment Account and a Safe Box. An Investment Account is used to put money to work, expecting to make more money, while a Safe Box is where cash is kept to accumulate or spend in the short term.
Investing is more about building wealth than just saving money.